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Despite strong economy, worrying financial signs for higher education

Earlham College in Indiana might lack a national brand name, but as Rick Seltzer pointed out in the online publication Inside Higher Ed recently, it's "not an average down-on-its-luck liberal arts college." It has an endowment of $438 million and draws about half of its students from outside the Midwest.

That's what makes the college's announcement of a nearly $13 million deficit even more surprising. As a result, Earlham is cutting $8 million from its $50 million budget. In late June, a few weeks after the announcement, the college said its president of just one year was leaving.

While the news roiled the campus of 1,000 students and its alumni, what is happening at Earlham is in many ways emblematic of the financial issues facing much of higher education these days. A few weeks ago, Moody's Investors Service said that 25 percent of private colleges are running deficits. The news isn't much better for public universities, according to Moody's. Last year, revenue at state-run schools grew 2.9 percent while expenses jumped 4.8 percent - the second consecutive year that expenses outpaced revenue.

Moody's examines the finances of more than 500 colleges and universities that issue debt through the public markets. So while it doesn't follow all colleges and universities, Moody's tends to look at the strongest players, and its ratings provide a good indicator of the strengths and weaknesses of colleges and universities.

In the public and private sectors, reports from Moody's tell a tale of a growing divide in higher education. Large public research universities, such as the University of Maryland at College Park, the University of Michigan, Arizona State University and other top public schools, hold more than 90 percent of the total cash and investments in the sector, despite enrolling 80 percent of the students. Among privates, the top quarter of colleges and universities hold 85 percent of all cash and investments.

What's especially troublesome for colleges and universities is that these trends are emerging in a strong economy and as higher education heads into a period of stagnation among traditional high school graduates nationwide. The number of high school graduates is projected to rise slightly in the middle of the next decade. Then, between 2026 and 2031, the ranks of high school graduates are expected to drop by 9 percent. In that period, four-year colleges nationwide stand to lose almost 280,000 students. In addition, the number of white graduates is expected to decrease sharply, while the number of Hispanic graduates grows substantially.

These demographic headwinds come as a new generation of students with different needs and motivations arrives. Generation Z, born beginning in the late 1990s, has replaced millennials on campus. "Unlike millennials who were willing to pay for the college experience and go into debt for it, Gen Z is more focused on value and price," said Corey Seemiller, an assistant professor at Wright State University and co-author of "Generation Z Goes to College." Most of all, Seemiller said, this is a generation that saw its predecessors amass more than $1.3 trillion in student debt and doesn't want to do the same.

That means colleges won't have much of an ability to raise prices in the future, putting more pressure on them to cut costs, develop different pricing models or build entirely new models for the traditional four-year residential college.

One of those new models comes from Paul Quinn College in Texas. A decade ago, the college was on the brink of closure, but now it's receiving national publicity for its work-college model. All Paul Quinn students, regardless of financial need, are required to work at least eight hours a week, first on campus, then off campus for participating employers. Part of students' pay goes to offset their tuition, and the rest is a cash payout. Students' supervisors double as their mentors.

Paul Quinn's president, Michael Sorrell, wants to create a national network of work colleges. Last month he took the first step toward that vision, announcing that the school would open a second campus in Plano, Texas, and partner with companies that include FedEx, JPMorgan Chase and Liberty Mutual to sponsor internships.

"America's colleges and universities," Sorrell said, "need to change and do more to address the needs of students."

Indeed, one needs only to look through the Moody's reports on public and private colleges and the research on what Generation Z wants out of college to know that major changes are on the horizon for higher education. The question is whether college leaders will be able to find the right solutions, and in enough time.

This article was written by Jeff Selingo, the author of There Is Life After College.